Beyond the 5 Cs of Commercial Mortgages

Commercial mortgage originators are familiar with the 5 Cs used to evaluate prospective borrowers — credit, collateral, character, capacity and common sense. Borrowers are often much less familiar with the standards, and they benefit when originators can explain how each influences lending decisions.

Loan originators know that working in the small-balance commercial mortgage niche can lead to more closed loans and additional income. The small-balance market — which typically encompasses properties priced under $5 million — is full of opportunity for enterprising originators, particularly when they choose to work with portfolio lenders. These lenders don’t sell off their loans and don’t rely on investors for financial support, which allows for more flexibility and understanding of each loan scenario submitted.

Choosing to work with nontraditional portfolio lenders means originators need to connect with a variety of companies, depending on the nature of the borrowers they service and the deals they are attempting to complete. The list includes conventional small-balance lenders, hard money specialists and those who accept receivables or leases as collateral.

It’s important to have a general understanding of how these lenders underwrite their loans before submitting financing requests. In many cases, nontraditional portfolio lenders evaluate borrowers by taking a hard look at the five C’s of the underwriting process — credit, collateral, character, capacity and common sense.

Originators can improve the outcomes for their clients by recognizing and connecting each of these key pieces in the underwriting jigsaw puzzle. Separately, these pieces have some value, but they don’t provide a lender with the full picture of borrowers and their creditworthiness. When pieced together, however, they provide a lender with a clearer picture of each borrower’s unique situation.

Elements of credit

A borrower’s credit history is one of the most important tools a lender can use to evaluate a loan application. It also is important, however, for originators to keep in mind that for nontraditional portfolio lenders, a credit score is a lot like the score on a SAT college admission exam. It’s an important number, and it gives your lender crucial information about your borrower, but it’s not the only thing these lenders will consider.

Colleges and universities take a high school senior’s SAT scores into account when making an admission decision, but they also consider the student’s grade-point average, extracurricular activities and a bevy of other information to make a well-informed choice. Likewise, nontraditional portfolio lenders will consider a borrower’s credit score and history carefully, but they also will evaluate the borrower’s business, property and story. These lenders listen to borrowers and understand the challenges small business owners face on a daily basis.

That being said, originators should always provide a recent credit report containing scores and trade lines in order to present lenders with the most accurate, up-to-date and easily understandable information about their clients. Often, these reports also will help you, as an originator, to better understand your client’s situation and make you better-equipped to sell the loan.

If your borrower’s credit score shows any blemishes, a letter of explanation at the beginning of the process is an important deal-enhancer. This added document, explaining why your borrower faced credit issues and how they were overcome, can mean the difference between a yes or no decision on the loan.

Collateral foundation

For nontraditional portfolio lenders, a borrower’s collateral is an important piece of the underwriting process. Lenders generally secure each loan with a borrower’s commercial property and rely on originators to provide as much property information as possible.

Remember to check each lender’s guidelines concerning where they will lend and the types of commercial property they will lend on. If the lender seems like a good prospect, provide the location and a detailed description of the property to allow your lender to research the property more thoroughly. Photos will help the lender get a feel for the property and better evaluate the mortgage request.

Additionally, it’s important for originators to provide information about whether the property is owner-occupied, tenant-occupied or another type of investment property. Whether your borrowers run their businesses from the property or rent the real estate out, the lender will need documents indicating who is doing business there and what type of business is being conducted at the location to determine if they will underwrite the mortgage.

Finally, the lender will need to know the value of the property. For refinances, originators should indicate when the borrower purchased the property and how much they paid for it. Recent appraisals are often helpful, but many portfolio lenders will want to order their own appraisal of the property. For purchases, provide the agreement of sale for the property.

Quantifying character

Character, arguably the most intangible factor when originators and lenders are working to close commercial mortgages, is particularly important when working with nonbankable borrowers who cannot obtain traditional financing. For a portfolio lender, understanding and trusting the borrower is a critical test that often replaces the verification of a tax return. This step is critical in convincing a lender to approve a borrower’s financing request.

In order to determine the character of each borrower for themselves, originators need to ask the right questions. It’s important to understand what kind of debts your borrower has incurred and how they were incurred. It also is crucial to understand how your borrower resolved, or plans to resolve, any financial difficulties.

Before submitting a loan scenario, originators should conduct a quick Internet search to gain more information about their clients. Borrowers sometimes omit certain details that they suspect will prevent them from receiving a commercial mortgage, but it’s best to know those details early in the lending process. In short, always encourage your borrowers to be upfront and honest about any past financial issues. Honesty and openness go a long way when working with nontraditional portfolio lenders.

Capacity to repay

Unlike banks and other traditional lenders, nontraditional portfolio lenders don’t rely on tax returns to underwrite their commercial mortgages. These lenders need to know, however, that borrowers have the ability to make their monthly payments.

It’s important for originators to provide relevant financial documents regarding the borrower’s business, such as profit-and-loss statements or leases. Originators also should understand the concept of the debt-service coverage ratio — a measure of a property’s cash flow available to cover mortgage debt service — and how it figures into a lender’s underwriting process.

It is important that originators ask the right questions to find out whether their borrowers are behind on any debt payments and to determine exactly how the requested funds will be used. Tax returns are not necessarily of paramount importance to small-balance commercial lenders, but they will want to know that the returns have been filed with state and federal tax agencies.

Common-sense questions

Once you have the basics of a mortgage scenario pieced together, ask yourself, “Does all of this make sense?” Forget the percentages of this and ratios of that. The bottom line is whether it makes sense to lend on this deal. As an advocate for your client, you also need to decide whether this mortgage makes sense for the borrower.

With experience, a seasoned underwriter begins to develop a gut feeling about whether a deal makes sense or not when reviewing a loan application. They will know when there is something about the deal that just doesn’t feel right — although they may not pinpoint it in a first review. It’s only when they start pulling on threads, those fuzzy little details, and begin asking the right questions that the deal begins to unravel, or conversely gains strength.

An interesting exercise for originators to try before presenting applications to lenders is to ask themselves, “What would I want to know about this client and their borrowing needs if I were lending them my own money?” It may surprise you how many questions you have.

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Originators closing commercial mortgages with nontraditional portfolio lenders should be aware of the five C’s of commercial mortgage underwriting and how each piece of the puzzle can affect a financing request. It may take some work to get all of the puzzle pieces to fit together, but portfolio lenders are willing to listen to and work with open and honest commercial property owners. Originators who provide lenders with complete and candid information early in the underwriting process are likely to receive more approvals and close more deals.